Download Markets Perfect Competition - DSS

Perfectly Competitive Market
Sunitha.S
Assistant Professor
School of Management Studies,
National Institute of Technology (NIT) Calicut
MARKETS AND ITS FORMS
 The four distinct market models are;
 Perfect Competition
 Monopolistic Competition
 Oligopoly
 Pure Monopoly
PERFECT COMPETITION
Characteristics
 Large number of Buyers and Sellers
 Standardized/Homogeneous Product
 Price Takers
 Free Entry and Exit
 Perfect knowledge about the market condition
EQUILIBRIUM OF A PRICE TAKER FIRM IN
SHORT RUN
 In short run the number of firms is fixed in the industry and firms
can only change its output level by changing the variable cost.
 A Firm’s equilibrium point can be ascertained by the following
two ways.
 Total Revenue & Total Cost Approach
 Marginal Revenue & Marginal Cost Approach
EQUILIBRIUM OF A PRICE TAKER FIRM IN
SHORT RUN “TR & TC APPROACH”
 A firm is in equilibrium and earns maximum profit when the
difference between TR and TC is highest.
 At any point, where TR touches TC curve, it will be a Break-even
point and here firm will earn Normal Profit.
 Normal profit does not mean Economic profit.
The Profit Motive
and the Results of Competition
The competitive firm’s demand curve
Perfect Competition: Price & Revenue
No:
Output
1
Price
Total
Revenue
Average
Revenue
Marginal
Revenue
10
10
10
2
10
20
10
10
3
10
30
10
10
4
10
40
10
10
Hence we say under perfect competition, Price=AR=MR
The competitive firm’s
demand curve
Rs
Quantity
The competitive firm’s
demand curve
Rs
Pm
MR = AR = P
Quantity
The optimal level of output for a
competitive firm is determined
where Marginal Revenue (MR)
is equal to Marginal Cost (MC).
Optimal Output Level
Rs
Quantity
Optimal Output Level
Rs
P*
MR = Demand or AR
Quantity
Optimal Output Level
Rs
MC
P*
MR = D=AR
Quantity
Optimal Output Level
MC
Rs
P*
MR = D=AR
Q*
Quantity
Average Total Cost (ATC) can be
added to the graph to demonstrate
the firm’s profit potential.
Average Total Cost
 The per unit cost of producing a
specific good.
 The difference between ATC and
product’s price equals the profit
per unit of product.
Average Total Cost
Rs
Quantity
Average Total Cost
Rs
ATC
Quantity
Average Total Cost
 Price - ATC = Profit per unit of
output
 Note: Price > ATC indicates a
profit
EQUILIBRIUM OF A PRICE TAKER FIRM IN
SHORT RUN “MR & MC APPROACH”
 MR & MC approach states that a price taker firm is in
equilibrium at a point where “MR or Price = MC”.
 The firm’s equilibrium point does not ensure that it is
producing that level of output which gives firm maximum
profit.
 In short run, a firm is faced with four types of product
prices in the market which give rise to following results;




A firm earns Supernormal Profit
A firm earns Normal Profit
A firm incurs Losses but does not Close Down
A firm minimizes Losses by Shutting Down
Rs
Quantity
Rs
P*
MR = D
=AR= P
Quantity
MC
Rs
P*
MR = D
=AR = P
Q*
Quantity
Rs
MC
ATC
P*
MR = D
AR = P
Quantity
MC
Rs
ATC
P*
MR = AR
=P
Q*
Quantity
MC
Rs
ATC
P*
Profit
MR = D=
AR = P
Q*
Quantity
Profit
 Price - ATC = Profit per unit of
output
 Note: Price < ATC indicates a
loss
Profit
 It is important to note that profit in a
perfectly competitive market will lead
to firms wanting to enter that market
 If enough firms enter, then the
market supply curve will shift to the
right.
S
Rs or
Price
Pe
D
Qe
Quantity
S
Rs or
Price
S
Pe
D
Qe
Quantity
Profit
 With the increase in Supply, price
will be driven down.
 With the lower price, profits will be
driven out.
Rs
Quantity
Rs
P*
MR = D
=P
Quantity
Rs
P*
MC
MR = D
=AR= P
Quantity
Rs
P*
MC
ATC
MR = D
=AR = P
Quantity
MC
Rs
ATC
MR = D
=AR= P
P*
Q*
Quantity
MC
Rs
P*
ATC
Loss
MR = D
AR= P
Q*
Quantity
Price
S
Pe
D
Qe
Quantity
Price
S
S
Pe
D
Qe
Quantity
Summarise
 Perfect competition s a myth an not a reality
 Firm is in equilibrium when MC =MR
 Firm maximizes the profit when the price
exceeds the AC.
 In the short run firms earn either supernormal
profits(when AR exceeds AC),losses(when
AC exceeds the AR)or will be forced to shut
down(when AR falls short of AVC)
Long Run Equilibrium
 Long run shows the entry and exit of the firms
into the industry. If firms make supernormal
profits in the SR, new firms will enter the
industry till the excess profits get wiped out.
 Similarly, If firms are making losses ,existing
firms will quit the industry so that the
remaining ones will be able to make at least
normal profits.
 Thus, under long run , firm and industry under
perfectly competitive market will earn only
normal profits.